The important legal agreement to protect Startups and Founders in Nigeria

From over 5 years of practice, I have noticed one extremely important legal agreement that most startups in Nigeria are either unaware of or haven’t fully taken advantage of. This agreement is referred to as “the Vesting Agreement”. Quickly, before we go into the nitty-gritty of a vesting agreement, I will like to explain what “vesting” is and what are “vesting agreements or clauses”, strictly in the context of its functionality to a Nigerian startup.

Vesting is a process by which benefits, privilege, authority, rights, or interest in an asset or property passes unconditionally to a person; whether natural or artificial person. A natural person being a human being or an artificial person being a company or institution; a legal entity by virtue of the Companies and Allied Matters Act, 2004.

In Nigeria, vesting seems more common in an area such as energy (in which electricity generation and distribution companies entered a vesting agreement of 15 years), and less and less in the startup or tech space, which is a huge error. Although, vesting is not expressly provided for under Nigerian law, it is a smart business and contractual consideration that can be enforced in the Nigerian court like any other valid contract.

Why Vesting Agreements are important

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Now, a vesting agreement (or clause) is an arrangement that spells out which benefits, privilege, authority, rights, or interest in an asset or property (which includes a startup) accrue to who and at what time. Vesting agreements ensure that at the beginning of the startup, founders get their full allotment of shares or equity stake to avoid double taxation, nevertheless, the company has the right to acquire a percentage of a founder’s equity in case he or she walks away. This means that if your partner walks away after a couple of months, he or she will not be able to claim the full worth of the company. The company would reserve the rights to acquire the run-away partners’ equity when he or she leaves the company.

Some years ago, a client who was referred to me called me up complaining that he and his friend started an “App”, but after a while, the other partner got tired and walked away, without looking back. My client decided to keep working on getting traction and investments for it, until one day, a member of the Lagos Angel Network (LAN) offered to buy a large interest in it. This made the news, and it was not long before the run-away partner, gave a phone call to my client asking for half the share of the monies received. This could have been solved by a vesting agreement prepared by a lawyer with understanding on startups.

I will also like to use the Facebook case, since Mark visited Nigeria recently. However, Mark wouldn’t have been “The Mark Zuckerberg” but for a legally binding vesting agreement that secured his interests in Facebook, even in the midst of law suits. How, you might ask? Remember, the movie, The Social Network — Zuckerberg’s friend (besides the twin brothers) returned to demand for his stake as co-founder with significant interest in the Facebook, but his claims couldn’t hold water, because the vesting agreement provided for a significant decline in shares, if a founder is inactive.

In effect, vesting protects partners from each other and aligns incentives so everybody focuses towards the common goal of building a sustainable, rewarding, and successful company, much more than a mere partnership agreement would do.

How startup vesting works

Unlike clauses in a partnership agreement, vesting clauses for startups are usually prepared to last 4 years, with a 1 year cliff. This means that if you had 50% equity and leave after two years you will only retain 25%. The longer you stay, the larger percentage of your equity will be vested until you become fully vested in the 48th month (four years).

Each month that you actively work full-time in your company, 1/48th of your total equity package will vest onto you. However, because you have a one year cliff, if one of the founders leaves the company before the 12th month, then he or she walks away with nothing; whereas staying until day 366 means you get one-fourth of your stocks vested instantly.

Say, for instance, your company gained some traction and raised investment during its 24th month, and the equity was divided 35% for yourself, 35% for your partner and 30% for the investors. Should your partner walk away he will hold 17.5%. What happens with the other 17.5%? Nothing! It virtually disappears after the company has repurchased it from your partner. Remember, when the company was registered, a fixed number of shares- say 2,000,000 units- were issued to cover 100% of equity. If the previously mentioned example occurs, 350,000 shares vanish representing that 17.5%, bringing down the total to 1,650,000 shares. All the other shareholders benefit because now they have a larger percentage of the company. On the other hand, if the startup gets acquired before the founders are fully vested, then each founder (partner) vesting literally accelerates until all – or at least most shares get vested.

A sample vesting agreement

In conclusions, as we have established the significance of a vesting agreement for a startup specifically, here is an example of a vesting clause or agreement I drafted for you below. I must emphasise the importance of seeking legal support from a startup lawyer with the understanding of the Nigerian business climate, in such circumstances.

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“Subject to terms of this agreement, vesting will occur based on the following schedule: Until and through [FIRST VESTING DATE], neither Founder’s shares will vest. On and not before [FIRST VESTING DATE]– [25%] of each Founder’s shares will vest. On and not before the 1st of every month thereafter, [1/36TH] of the remaining [75%]will vest. Thus, on [END DATE] (the “Full Vesting Date”), each Founder will be 100% vested. If either Founder ceases to provide services to the Company, resigns from the Company, or is terminated from service with the Company by a majority vote of the Founders according to their respective ownership interests, with or without cause or good reason, (the “Terminated Founder”) at any time prior to the Full Vesting Date (the “Termination Date”), none of the Terminated Founder’s additional shares shall vest. The Terminated Founder’s shares which has not vested as of the Termination Date shall be canceled or returned to the Company, and the Founder’s ownership interest shall be reduced by the amount of invested shares so canceled or returned.

{Additional clause on acquisition before full vesting} If both founders are still fully involved with the business and a liquidity event (such as the sale to a third party, an initial public offering, or other liquidity event) occurs, 100% vesting will occur immediately”.